Taiwan currently has the world's third largest foreign exchange reserves, US$185.7 billion at the end of August. Japan has the largest reserves, US$555.1 billion and China is second with over US$320 billion.
Last month, Taiwan's forex reserves increased by US$3.46 billion. According to the Central Bank's Foreign Exchange Department, the main reason behind this increase was a large influx of foreign capital, attracted mainly by Taiwan's stock market and interest on central bank investments.
In the late 1980s, Taiwan's accumulation of reserves led to pressure on the New Taiwan dollar to appreciate, which in its turn led to the transformation of Taiwan's infrastructure and the liberalization of capital markets. Ten years on, Taiwan has joined the WTO, and liberalization of capital markets continues. In the past, Taiwan accumulated huge amounts of foreign exchange as a result of trade surpluses. Today, the reason is foreign investment in Taiwan's capital markets, leading to gains of hundreds of millions of dollars in a single month.
Large amounts of foreign capital arrive quickly and leave just as quickly. As a matter of fact, the Central Bank did not mention Taiwan's greatest source of foreign capital apart from foreign investment -- Taiwan's trade surplus with China.
The reasons behind this surplus are changes in the distribution of work in the international economy, which means that China needs to import a lot of materials from Taiwan, and that Taiwanese businesses in China use the import of equipment and materials from their headquarters in Taiwan as a cover for transferring profits back to Taiwan.
Now that Taiwan is about to allow Taiwan-invested companies in China to be listed on the over-the-counter and the TAIEX and TAISDAQ stock markets, people are worried because such a move will cause Taiwan's capital markets to be more greatly affected by China. From a positive point of view, however, it will also allow the movement of capital in Taiwan-invested companies to become more transparent and this will help improve Taiwan's capital market operations.
From a Chinese perspective, China experienced a foreign exchange shortage in the early 1990s. Ten years on, it has become the world's second largest holder of foreign exchange reserves. On the one hand, China's accumulation of foreign exchange has created pressures on the yuan to appreciate. On the other hand, it has made Chinese officialdom and industry think about how to spend this foreign currency and how to find better investment opportunities overseas.
Hong Kong will be the main beneficiary. Chinese officialdom is gradually relaxing restrictions on foreign travel for Chinese citizens. Tourists may now bring 20,000 yuan out of the country instead of the previous 6,000 yuan.
According to an estimate by Hong Kong's Chinese-language daily Wenwei Po, this means that about 1.2 trillion yuan will flow into Hong Kong next year. In addition, Chinese industry will begin to invest and acquire companies overseas or import even more equipment. In short, China has to come up with ways of spending part of its foreign currency to alleviate pressures on the currency to appreciate and enjoy some of the fruits of development.
For Taiwan, the question of how to earn some of China's foreign currency reserves will become increasingly important. In the past, the worry was that China would attract all of Taiwan's capital. Someone described it as Taiwan giving money to China, allowing it to purchase weaponry. Now it is the Chinese people's turn to invest abroad. How will Taiwan spend the money? On education and social expenditures or even Aegis destroyers?